Good intentions need a solid backbone

Financial Express, 24 January 2007

This fiscal have yielded revenue growth much above targets. Among the reasons behind the increase in tax revenue has been high GDP growth, rationalisation of taxes and improvements in tax administration. The latter have increased tax buoyancy. Considering that cutting of tax rates and reduction of exemptions has increased revenue collection, there should be further cuts in tax rates. Removal of exemptions of various kinds and removal of the surcharge on income and corporate tax should go hand and hand in the sphere of direct taxes. Further steps towards a CENVAT for goods and services with full input credit would help the move towards a GST. Setting excise and service tax to a uniform rate can be done without worrying about raising deficits.

The last two years have seen a reduction in fiscal deficits and it is projected that this year fiscal deficits may do better than targets. While this is great news for the finance ministry, it is going to increase pressures to raise expenditures which may be difficult to cut in future years when the going is not so good. Reports suggest that already there is pressure from the Planning Commission to give a higher budget allocation for plan expenditure. While there appears to be consensus on the direction towards which tax policy must move, it is on expenditure that even within the UPA there does not seem to be unanimity of approach.

Should the coming budget increase expenditures given that revenues have risen sharply or should it try to continue looking towards reducing spending and cutting fiscal deficits? If expenditures are to be increased to give growth a human face, what kind of spending would do this best?

Some economists would argue that when tax revenue collections are high the government should not have a tax and spend policy but should use the additional revenue to retire debt, reduce the future burden of interest payments which are today eating up nearly half of government current spending and free up our children from the burden of servicing our debt. However, even the Fiscal Responsibility Act only requires the government to meet fiscal deficit targets, not exceed them when there is a high of a business cycle and revenues do exceptionally well, and it may perhaps be unrealistic to expect this.

It may be more realistic to ask how the extra money available should be spent. There is consensus more capital expenditure on infrastructure is needed. In infrastructure projects, as opposed to increasing welfare expenditure is that the big costs are one-off. Expenditures on maintenance will need to be borne later but these are usually lower than the initial cost of the project. Further, contracts such as those being adopted by NHAI put the responsibility of these on the contractor who is given the right to collect user charges.

In addition to expenditure on infrastructure, a significant part of the proposed additional expenditure is on welfare schemes and public services. Welfare schemes are usually done with a view to political gains. The UPA should carefully assess the political benefits of these schemes.

Take the case of the NREGA. The scheme will give benefits to the Congress Party only if well implemented. But even here, there is a catch. The central government may spend thousands of crores on the NREGA, but some beneficiaries may give credit to the central government for spending on the scheme, rather than to the state government (which could well be a BJP government as in Rajasthan or MP), for good implementation.

Or, consider the huge spending programs on health and education that are being proposed. Despite the fact that the current systems are not working, the UPA appears to be all set to spend more money without fixing the systems. As the recent Pratham reports shows, parents - and particularly parents in rural areas - continue to defect away from public sector schools or health facilities and shift over to private schools and private health providers. The quality of education being provided by the government system is abysmal. But once a school is started and government teachers hired, no matter how bad it is, it never gets shut down.

So if the government has to tax and spend, it would be best to spend the additional revenue earned on infrastructure projects like roads rather than on welfare schemes. No only do they lead to capacity building and lay the foundations for higher growth, such expenditures don't become a permanent liability for the government. Morevoer, in rural India when schools are near roads, staff and teacher hiring and performance gets better. The National Family Health Survey results show that one of the most powerful ways of improving public health in a village is to build roads to it. Public works programes which build a road are needed in villages which are not well connected by roads. Those areas which have access to roads create a better environment for finding employment and for migration. For urbanisation of rural and semi-rural India, the availability of facilities and the growth in commerce, factors that will help growth will come through infrastructure and not government schemes.

The difficulties in the present systems of health and education were outlined in the first draft of the eleventh plan approach paper that was released by the Planning Commission. Instead of incurring expenditures which permanently raise public expenditure, the focus should be on incurring one-off costs for infrastructure projects contracted in ways so as to limit future liabilities. At the end of the day every rupee spent on roads can do much more to reduce poverty and take health and education to the the poor than can poorly working public services.

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